International Monetary Economics

International Monetary Economics 1. Show graphically the short term effect of a drop in the interest rate offered by Euro deposits, R$, and the effect on the exchange rate, . 2. Suppose there is a reduction in aggregate real money demand, that is, a negative shift in the aggregate real money demand function. Trace the short and long-run effects on the exchange rate, interest rate and price levels. Use the asset approach to the balance of payments [chapters 14 (3) and 15 (4)]. 3. The velocity of money, V, is defined as the ratio of real GNP to real money holdings. Then, in chapter 15 (4) notation V=Y/(M/P). Use equation 4 in chapter 15 (4) to derive an expression for velocity and explain how velocity varies with changes in R and Y. (Hint: the effect of output changes on V depends on the elasticity of aggregate money depend with respect to output, which economists believe to be less than one). What is the relationship between velocity and the exchange rate? 4. Explain (graphically) why an increase in the money supply generates an overshoot of the exchange rate in the short run in the “Asset Approach” to the balance of payments. Explain the figure thoroughly. 5. Graphically show the effect of a decrease in the growth rate of the money supply on the exchange rate under the assumptions of the “Monetary Approach” to the balance of payments. 6. At the end of World War I, the Treaty of Versailles imposed an indemnity on Germany, a large annual payment from it to the victorious Allies. (Many historians believe this indemnity played a role in destabilizing financial markets in the interwar period and even in bringing on World War II.) In the 1920s, economist John Maynard Keynes and Bertil Ohlin had a spirited debate in the Economic Journal over the possibility that the transfer payment would impose a “secondary burden” on Germany by worsening its terms of trade. Use the theory developed in this chapter to discuss the mechanism through which a permanent transfer from Poland to the Czech Republic would affect the real zloty/koruna exchange rate in the long run. 7. Continuing with the preceding problem, discuss how the transfer would affect the long-­-run nominal exchange rate between the two currencies. 8. Can you suggest an event that would cause a country’s nominal interest rate to raise and its currency to appreciate simultaneously, in a world with perfectly flexible prices? Register in the United States’ Real and Financial Flows Matrix the following situation. The European Central Bank decides to increase the real money supply while European governments decide to expand their expenditures and the private sector in Europe maintains their level of expenditure. Assume that international transactions are made in Euros but Americans if they have any Euro they exchange it for dollars at the Fed.